Though enhancing the wealth of the owners may not be a perfect description of
what businesses seek to achieve, it is certainly something that businesses cannot ignore
for the reasons mentioned. For the remainder of this book enhancement/maximisation
of shareholders’ (owners’) wealth is treated as the key financial objective against which
decisions will be assessed. There will usually be other non-financial/non-economic
factors that will also tend to bear on decisions. The final decision may well involve
some compromise.
Balancing risk and return
All decision making involves the future. We can only make decisions about the future;
no matter how much we may regret it, we cannot alter the past. Business decision mak-
ing is no exception to this general rule. There is only one thing certain about the
future, which is that we cannot be sure what is going to happen. Sometimes we may
be able to predict with confidence that what actually occurs will be one of a limited
range of possibilities. We may even feel able to ascribe statistical probabilities to the
likelihood of occurrence of each possible outcome, but we can never be completely cer-
tain of the future. Risk is therefore an important factor in all financial decision mak-
ing, and one that must be considered explicitly in all cases.
As in other aspects of life, risk and return tend to be related. Evidence shows that
returns relate to risk in something like the way shown in Figure 1.4.
This relationship between risk and return has important implications for setting
financial objectives for a business. The owners (shareholders) will require a minimum
return to induce them to invest at all, but will require an additional return to com-
pensate for taking risks; the higher the risk, the higher the required return. Managers
must be aware of this and must strike the appropriate balance between risk and return
when setting objectives and pursuing particular courses of action.
Real World 1.10 describes how some businesses have been making higher-risk
investments in pursuit of higher returns.
CHAPTER 1 INTRODUCTION TO MANAGEMENT ACCOUNTING
14
Relationship between risk and return

What is management accounting?
WHAT IS MANAGEMENT ACCOUNTING?
15
REAL WORLD 1.10
Appetite for risk drives businesses
Over the last few years, companies from the US and western Europe, joined increasingly
by competitors from China and India, have looked to new markets abroad both to source
and sell their products.
Driven by intensifying competition at home, companies have been drawn into direct
investment in markets that not long ago were considered beyond the pale. But in the drive
to increase returns, they have also been forced to accept higher risks.
Over time, the balance between risk and reward changes. For example, companies
flooded into Russia early in the decade. But recently returns have fallen, largely due to
booming raw materials prices. Meanwhile the apparent risk of investing in Russia has
grown significantly.
As the risk–reward calculation has changed in Russia, companies have looked to other
countries such as Libya and Vietnam where the rewards may be substantial, and the
threats, though high, may be more manageable.
Source: Adapted from Stephen Fidler, ‘Appetite for risk drives industry’, ft.com, 27 June 2007.
FT
‘
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l borrow money to help finance the business (as with a supermarket wishing to
increase the number of stores it owns);
l increase or decrease the operating capacity of the business (as with a beef farming
business reviewing the size of its herd);
l change the methods of purchasing, production or distribution (as with a clothes
retailer switching from UK to overseas suppliers).
As management decisions are broad in scope, the accounting information provided

ager and the benefits which flow as a result cannot be accurately assessed. We shall see
below, however, that it is at least possible to identify the kinds of qualities that
accounting information must possess in order to be useful. Where these qualities are
lacking, the usefulness of the information will be diminished.
One way of viewing management accounting is as a form of service. Management ac-
countants provide economic information to their ‘clients’, the managers. The quality of
the service provided would be determined by the extent to which the managers’ infor-
mation needs have been met. It is generally accepted that, to be useful, management
accounting information should possess certain key qualities, or characteristics. These are:
l Relevance. Management accounting information must have the ability to influence
decisions. Unless this characteristic is present, there is really no point in producing
the information. This means that the information should be targeted at the require-
ments of the individual manager for whom it is being provided. Reports that are
general in nature are likely to be unhelpful to most managers. To be able to
influence a decision, the information must be available when the decision needs to
be made. To be relevant, therefore, information must be timely.
l Reliability. Management accounting should be free from significant errors or bias. It
should be capable of being relied upon by managers to represent what it is supposed
to represent. Though both relevance and reliability are very important, the problem
that we often face in accounting is that information that is highly relevant may not
be very reliable, and that which is reliable may not be very relevant.
Providing a service
PROVIDING A SERVICE
17
‘
‘
To illustrate this last point, let us assume that a manager has to sell a custom-built
machine owned by the business and has recently received a bid for it. This machine is
very unusual and there is no ready market for it.
What information would be relevant to the manager when deciding whether to

ter them up and, perhaps, interfere with the managers’ ability to interpret the finan-
cial results. The type of information and amounts involved will normally determine
whether it is material.
Having read the previous sections you may feel that, when considering a piece of
management accounting information, provided the four main qualities identified are
present and it is material it should be gathered and made available to managers.
Unfortunately, there is one more hurdle to jump. Something may still exclude a piece
of management accounting information from the reports even when it is considered
to be useful. Consider Activity 1.4.
Weighing up the costs and benefits
CHAPTER 1 INTRODUCTION TO MANAGEMENT ACCOUNTING
18
‘
‘
‘
Suppose an item of information is capable of being provided. It is relevant to a particu-
lar decision; it is also reliable and comparable; it can be understood by the manager
concerned and is material.
Can you think of a reason why, in practice, you might choose not to produce the
information?
The reason that you may decide not to produce, or discover, the information is that you
judge the cost of doing so to be greater than the potential benefit of having the infor-
mation. This cost–benefit issue will limit the extent to which management accounting
information is provided.
Activity 1.4
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In theory, a particular item of management accounting information should only be
produced if the costs of providing it are less than the benefits, or value, to be derived
from its use. Figure 1.6 shows the relationship between the costs and value of provid-

information provision is where the gap between the value of the information and the cost of pro-
viding it is at its greatest.
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l How long will it take to make all the telephone calls or visits?
l How much do we value our time?
The economic benefit of having the information on the price of the car repair is
probably even harder to assess, and the following points need to be considered:
l What is the cheapest price that we might be quoted for the car repair?
l How likely is it that we shall be quoted prices cheaper than £250?
As we can imagine, the answers to these questions may be far from clear.
Of course, were we to contact all of the garages and find out all of the prices, we
should know whether the exercise had been cost-effective. Unfortunately we cannot
know this for certain in advance. We need to make a judgement.
When assessing the value of accounting information we are confronted with similar
problems.
The provision of management accounting information can be very costly; however,
the costs are often difficult to quantify. The direct, out-of-pocket costs such as salaries
of accounting staff are not really a problem to put a price on, but these are only part
of the total costs involved. There are also less direct costs such as the costs of the man-
ager’s time spent on analysing and interpreting the information contained in reports.
CHAPTER 1 INTRODUCTION TO MANAGEMENT ACCOUNTING
20
The characteristics that influence the usefulness of
management accounting information
Figure 1.7
There are four main qualitative characteristics that influence the usefulness of management
accounting information. In addition, however, management accounting information should be
material and the benefits of providing the information should outweigh the costs.
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There are four sequential stages of a management accounting information system. The first two
stages are concerned with preparation, whereas the last two stages are concerned with using
the information collected.
Given the decision-making emphasis of this book, we shall be concerned primarily
with the final two elements of the process – the analysis and reporting of manage-
ment accounting information. We shall consider the way in which information is
used by, and is useful to, managers rather than the way in which it is identified and
recorded.
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Though management accounting has always been concerned with helping managers
to manage, the information provided has undergone profound changes over the years.
This has been in response to changes in both the business environment and in busi-
ness methods. The development of management accounting is generally accepted to
have had four distinct phases.
Phase 1
Until 1950, or thereabouts, businesses enjoyed a fairly benign economic environment.
Competition was weak and, as products could easily be sold, there was no pressing
need for product innovation. The main focus of management attention was on the
internal processes of the business. In particular, there was a concern for determining
the cost of goods and services produced and for exercising financial control over the
relatively simple production processes that existed during that period. In this early
phase, management accounting information was not a major influence on decision
making. Although cost and budget information was produced, it was not widely sup-
plied to managers at all levels of seniority.
Phase 2
During the 1950s and 1960s management accounting information remained inwardly
focused; however, the emphasis shifted towards producing information for short-term
planning and control purposes. Management accounting came to be seen as an import-
ant part of the system of management control and of particular value in controlling

particular emphasis on creating value for shareholders by understanding customer
needs (see reference 2 at the end of the chapter). This change resulted in management
accounting information becoming more outwardly focused. The attitudes and
behaviour of customers have become the object of much information gathering.
Increasingly, successful businesses are those that are able to secure and maintain com-
petitive advantage over their rivals through a greater understanding of customer needs.
Thus, information that provides details of customers and the market has become
vitally important. Such information might include customers’ evaluation of services
provided (perhaps through the use of opinion surveys) and data on the share of the
market enjoyed by the particular business.
We have seen that management accounting can be regarded as a form of service where
managers are the ‘clients’. This raises the question, however, as to what kind of infor-
mation these ‘clients’ require. It is possible to identify four broad areas of decision mak-
ing where management accounting information is required.
l Developing objectives and plans. Managers are responsible for establishing the
mission and objectives of the business and then developing strategies and plans to
achieve these objectives. Management accounting information can help in gather-
ing information that will be useful in developing appropriate objectives and strat-
egies. It can also generate financial plans that set out the likely outcomes from
adopting particular strategies. Managers can then use these financial plans to evalu-
ate each strategy and use this as a basis for deciding between the various strategies
on offer.
l Performance evaluation and control. Management accounting information can help in
reviewing the performance of the business against agreed criteria. We shall see below
that non-financial indicators are increasingly used to evaluate performance, along
with financial indicators. Controls need to be in place to ensure that actual perform-
ance conforms to planned performance. Actual outcomes will, therefore, be com-
pared with plans to see whether the performance is better or worse than expected.
Where there is a significant difference, some investigation should be carried out and
corrective action taken where necessary.

‘
Management decisions requiring management accounting
information
Figure 1.9
Management accounting information is required to help managers to make decisions in four
broad areas: developing long-term plans and strategies, performance evaluation and control,
allocating resources and determining costs and benefits.
It can be argued that non-financial measures, such as those mentioned above, do not,
strictly speaking, fall within the scope of accounting information and, therefore, could
(or should) be provided by others. What do you think?
It is true that others could collect this kind of information. However, management account-
ants are major information providers to managers and usually see it as their role to pro-
vide a broad range of information for decision making. The boundaries of accounting are
not fixed and it is possible to argue that management accountants should collect this kind
of information as it is often linked inextricably to financial outcomes.
Activity 1.5
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Activity 1.6 considers the kind of information that may be expressed in non-
financial terms and which the management accountant may provide for an airline
business.
In Chapter 10 we shall look at some of the financial and non-financial KPIs that are
used in practice.
Management accounting information is intended to have an effect on the behaviour
of those working in the business. The reason for providing the information is to
improve the quality of the decisions. This should lead to actions that better contribute
to the fulfilment of the business objectives. In some cases, however, the behaviour
change caused by management accounting is not beneficial. One possible effect is
that managers and employees will concentrate their attention and efforts on the
aspects of the business that are being measured and will give much less attention to

Attempts may be made to manipulate a particular measure where it is seen as import-
ant. For example, a manager may continue to use old, fully depreciated pieces of
equipment to keep depreciation charges low and, therefore, boost profits. This may be
done despite knowledge that the purchase of new equipment would produce higher
quality products and help to increase sales revenue over the longer term. Attempts at
manipulation are often related to managers’ rewards. For example, profit-related bonuses
may provide the incentive to manipulate reported profits in the way described.
In some cases, the particular targets against which performance is measured are the
objects of manipulation. For example, a sales manager may provide a deliberately low
forecast of the size of the potential market for the next period if he or she believes that
this forecast will form the basis of future sales targets. This may be done either to
increase rewards (for example, where bonuses are awarded for exceeding sales targets)
or to ensure that future sales targets can be achieved with relatively little effort.
The management accountant must be aware of the impact of accounting measures
of performance on human behaviour. When designing accounting measures, it is
important to try to ensure that all key aspects of performance are taken into account,
even though certain aspects may be difficult to measure. When operating an account-
ing measurement system, it is important to be alert to behaviour aimed at manipulat-
ing particular measures rather than achieving the goals to which they relate.
The impact of information technology (IT) on the development of management
accounting is difficult to overstate. The ability of computers to process large amounts
of information means that routine reports can be produced quickly and accurately.
Indeed, certain reports may be produced on a daily, or even real-time, basis. This can
be vital to businesses operating in a highly competitive environment, which risk the
loss of competitive advantage from making decisions based on inaccurate or out-of-
date reports. IT has also enabled information to be more widely spread throughout the
business. Increasingly, through their personal computers, employees at all levels are able
to gain access to relevant information and reports to guide their decisions and actions.
IT has allowed management reports to be produced in greater detail and in greater
variety than could be contemplated under a manual system. In addition, it has allowed

the management team and, therefore, directly involved in planning and decision mak-
ing. This new dimension to the management accountant’s role has implications for the
kind of skills required to operate effectively. In particular, certain ‘soft’ skills, such as
interpersonal skills for working as part of an effective team and communication skills
to help influence the attitudes and behaviour of others, are needed.
This new dimension to the role of the management accountant should have bene-
fits for the development of management accounting as a discipline. When working
as part of a cross-functional team, the management accountant should gain a greater
awareness of strategic and operational matters, an increased understanding of the
information needs of managers and a deeper appreciation of the importance of value
creation. This is likely to have a positive effect on the design and development of man-
agement accounting systems. As a consequence, we should see increasing evidence that
management accounting systems are being designed to fit the particular structure and
processes of the business rather than the other way round.
By participating in planning, decision making and control of the business as well as
providing management accounting information for these purposes, the management
accountant plays a key role in achieving the objectives of the business. It is a role that
should add value to the business and improve its competitive position.
Real World 1.11 considers how management accountants are making an impact in
the UK National Health Service.
From bean counter to team member
FROM BEAN COUNTER TO TEAM MEMBER
27
REAL WORLD 1.11
Management accountants operating in the NHS
In many ways the National Health Service is in the same position as any private sector organisa-
tion. When it comes to running the organisation managers are expected to do more for the same.
The expectations of patients rise inexorably.
The limited resource is money. The NHS is a service industry. It is based on delivery and the
overwhelming amount of its cost base is people. So the big issues are productivity, getting better

This makes it a classic for treatment by fundamental management accountancy principles. . . .
‘The management accountant’s role is to bring discipline to the management process,’ says
Simon Wombwell, deputy chair of CIMA’s NHS working group. ‘It is not just costing services but
also trying to drive down costs. It is the reporting of key performance indicators, for example,’ he
says, ‘and the monitoring of the achievement of productivity and efficiency’ . . .
Transparent accounting, rather than the old ways of hushing up the issues, is the best way to
achieve long-term results. Increasingly the accountants are working in teams with senior clinicians
and senior nurses.
The vast majority of accountants in the NHS have worked within its systems for a good many
years.
They do understand the sometimes eccentric ways in which it all works.
In the past the systems stopped them doing much about it.
Now, if the politicians don’t get in the way too much, they can bring about the reforms that
could create a much more efficient and patient-focused NHS.
Source: Extracts from Bruce, R., ‘Physician, heal thyself’, Financial Times, 6 September 2006.
M01_ATRI3622_06_SE_C01.QXD 5/29/09 3:29 PM Page 28

Management accountants are likely to find themselves at the forefront with issues
relating to business ethics. In the three examples of unethical business activity listed
above, a management accountant would probably have to be involved either in help-
ing to commit the unethical act or in covering it up. Management accountants are,
therefore, particularly vulnerable to being put under pressure to engage in unethical
acts. Some businesses recognise this risk and produce an ethical code for their account-
ing staff. Real World 1.13 provides an example of one such code.
Management accounting is one of two main strands in accounting; the other strand
is financial accounting. The difference between the two is based on the user groups
to which each is addressed. Management accounting seeks to meet the needs of
Management accounting and financial accounting
MANAGEMENT ACCOUNTING AND FINANCIAL ACCOUNTING
29

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managers, whereas financial accounting seeks to meet the accounting needs of the
other users that were identified earlier in Figure 1.5 (see p. 16).
The difference in their constituencies has led to each strand of accounting develop-
ing along different lines. It is probably worth looking at the ways in which each strand
has developed in order to gain a deeper appreciation of how management accounting
differs from financial accounting.
l Nature of the reports produced. Financial accounting reports tend to be general-
purpose. That is, they contain financial information that will be useful for a broad
range of users and decisions rather than being specifically designed for the needs
of a particular group or set of decisions. Management accounting reports, on the
other hand, are often specific-purpose reports. They are designed either with a par-
ticular decision in mind or for a particular manager.
l Level of detail. Financial accounting reports provide users with a broad overview of
the performance and position of the business for a period. As a result, information
is aggregated and detail is often lost. Management accounting reports, however,
often provide managers with considerable detail to help them with a particular
operational decision.
l Regulations. Financial accounting reports, for many businesses, are subject to
accounting regulations that try to ensure they are produced with standard content
and in a standard format. The law and accounting rule makers impose these regula-
tions. As management accounting reports are for internal use only, there are no
regulations from external sources concerning the form and content of the reports.
They can be designed to meet the needs of particular managers.
l Reporting interval. For most businesses, financial accounting reports are produced
on an annual basis, though large businesses may produce half-yearly reports, and
a few produce quarterly ones. Management accounting reports may be produced
as frequently as required by managers. In many businesses, managers are pro-
vided with certain reports on a daily, weekly or monthly basis, which allows

vided. Though the scope of financial accounting reports has increased over time, fears
concerning loss of competitive advantage and user ignorance concerning the reliabil-
ity of forecast data have led businesses to resist providing other users with the detailed
and wide-ranging information available to managers.
In the past it has been argued that accounting systems are biased in favour of pro-
viding information for external users. Financial accounting requirements have been
the main priority and management accounting has suffered as a result. Recent survey
evidence suggests, however, that this argument has lost its force. Nowadays, manage-
ment accounting systems will usually provide managers with information that is rel-
evant to their needs rather than that determined by external reporting requirements.
External reporting cycles, however, retain some influence over management account-
ing, and managers are aware of external users’ expectations. (See reference 3 at the end
of the chapter.)
Though the focus of this book is management accounting as it relates to private sector
businesses, there are many organisations that do not exist mainly for the pursuit of
profit yet produce management accounting information for decision-making purposes.
Examples of such organisations include charities, clubs and associations, universities,
national and local government authorities, churches and trades unions. Managers need
accounting information about these types of organisation to help them to make deci-
sions. The objectives of not-for-profit organisations will not be concerned with the cre-
ation of wealth for shareholders, but with creating wealth for the organisations and
effectively applying that wealth towards the achievement of their mission.
Not-for-profit organisations are not exempt from the changes that have taken place
in the world. They too must be ‘customer’ orientated and are under increasing pressure
to deliver value for money in the manner in which they operate.
Not-for-profit organisations
NOT-FOR-PROFIT ORGANISATIONS
31
Are the information needs of managers and those of other users so very different?
Is there any overlap between the information needs of managers and the needs of

Source: Adapted from Bruce, R., ‘Tsunami: finding the right figures for disaster’, ft.com, 7 March 2005; Bruce, R., ‘The work of
Mango: coping with generous donations’, ft.com, 27 February 2006.
FT
The main points of this chapter may be summarised as follows:
What is the purpose of a business?
l To create and keep a customer.
How are businesses organised and managed?
l Most businesses of any size are set up as limited companies.
l A board of directors is appointed by shareholders to oversee the running of the
business.
l Businesses are often divided into departments and organised along functional lines;
however, larger businesses may be divisionalised along geographical and/or product
lines.
Strategic management
l The move to strategic management has been caused by the changing and more com-
petitive nature of business.
l Strategic management involves five steps:
1 Establish mission and objectives.
2 Undertake a position analysis (for example, a SWOT analysis).
3 Identify and assess strategic options.
4 Select strategic options and formulate plans.
5 Perform, review and control.
SUMMARY
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The changing business landscape
l Increased competition and advances in technology have changed the business land-
scape in the UK.
l There have been changes in the types of businesses operating as well as changes in
the ways in which businesses are structured and operate.

Reaping the benefits of IT
l IT has had a major effect on the ability to provide accurate, detailed and timely
information.
l Developments in IT have enabled information and reports to be more widely dis-
seminated throughout the business.
Changing role of the management accountant
l Less time is spent preparing reports.
l The management accountant is now a key member of the management team.
l This new dimension to the management accountant’s role should benefit the design
of more relevant management accounting information systems.
SUMMARY
33
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Ethical behaviour
l Management accountants may be put under pressure to commit unethical acts.
l Many businesses now publish a code of ethics governing their behaviour.
Management accounting and financial accounting
l Accounting has two main strands – management accounting and financial accounting.
l Management accounting seeks to meet the needs of businesses’ managers, and
financial accounting seeks to meet the needs of the other user groups.
l These two strands differ in terms of the types of reports produced, the level of report-
ing detail, the time horizon, the degree of standardisation and the range and qual-
ity of information provided.
Not-for-profit organisations
l Not-for-profit organisations also require management accounting information for
decision-making purposes.
1 Drucker, P., The Effective Executive, Heinemann, 1967.
2 Abdel-Kader, M. and Luther, R., ‘An empirical investigation of the evolution of management
accounting practices’, University of Essex Working Paper No. 04/06, October 2004.

Key terms
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EXERCISES
35
REVIEW QUESTIONS
EXERCISES
Answers to these questions can be found in Appendix C at the back of the book.
Identify the main users of accounting information for a university. For what purposes would
different user groups need information? Do these users differ very much from the users of
accounting information for private sector businesses?
Management accounting has been described as ‘the eyes and ears of management’. What do
you think this expression means?
Assume that you are a manager considering the launch of a new service. What accounting infor-
mation might be useful to help in making a decision?
‘Accounting information should be understandable. As some managers have a poor knowledge
of accounting we should produce simplified financial reports to help them.’ To what extent do
you agree with this view?
1.4
1.3
1.2
1.1
Exercise 1.2 is more advanced than 1.1. Both have answers in Appendix D at the back of the
book, starting on p. 480. If you wish to try more exercises, visit the students’ side of the
Companion Website at www.pearsoned.co.uk/atrillmclaney.
You have been speaking to a friend who owns a small business and she has said that she has
read something about strategic management and that no modern business can afford not to get
involved with it. Your friend has little idea what strategic management involves.
Required:

A sufficient profit has been made to enable the directors to enjoy a reasonable income com-
pared with their needs, but only by raising prices. Currently Jones charges 40p for a standard
pint, delivered. This is fairly typical of doorstep delivery charges around the UK. The Trepont
supermarket, which is located in the centre of town, charges 26p a pint and other local stores
charge between 35p and 40p.
Currently Jones employs 15 full-time rounds staff, a van maintenance mechanic, a secret-
ary/bookkeeper and the two directors. Jones is regarded locally as a good employer. Regular
employment opportunities in the area are generally few. Rounds staff are expected to, and gen-
erally do, give customers a friendly, cheerful and helpful service.
The two brothers continue to be the only shareholders and directors and comprise the only
level of management. One of the directors devotes most of his time to dealing with the supplier
and with issues connected with details of the rounds. The other director looks after administra-
tive matters, such as the accounts and personnel issues. Both directors undertake rounds to
cover for sickness and holidays.
Required:
As far as the information given in the question will allow, undertake an analysis of the strengths,
weaknesses, opportunities and threats (a SWOT analysis) of the business.
CHAPTER 1 INTRODUCTION TO MANAGEMENT ACCOUNTING
36
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Relevant costs for decision
making
LEARNING OUTCOMES
This chapter considers the identification and use of costs in making management
decisions. These decisions should be made in a way that will promote the business’s
achievement of its strategic objective. We shall see that not all of the costs that
appear to be linked to a particular business decision are relevant to it. It is important
to distinguish carefully between costs (and revenues) that are relevant and those
that are not. Failure to do this could well lead to bad decisions being made.

reject both offers.)
We may still feel, however, that the £5,000 is relevant here because it will help us in
assessing the profitability of the decision. If we sold the car, we should make a profit of
either £500 (£5,500 − £5,000) or £1,000 (£6,000 − £5,000) depending on which offer
we accept. Since we should seek to make the higher profit, the right decision is to sell
the car for £6,000. However, we do not need to know the historic cost of the car to
make the right decision. What decision should we make if the car cost us £4,000 to
buy? Clearly we should still sell the car for £6,000 rather than for £5,500 as the import-
ant comparison is between the offer price and the opportunity cost. We should reach
the same conclusion whatever the historic cost of the car.
To emphasise the above point, let us assume that the car cost £10,000. Even in this
case the historic cost would still be irrelevant. If we have just bought a car for £10,000
CHAPTER 2 RELEVANT COSTS FOR DECISION MAKING
38
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‘
‘
You own a motor car, for which you paid a purchase price of £5,000 – much below the
list price – at a recent car auction. You have just been offered £6,000 for this car.
What is the cost to you of keeping the car for your own use? Note: Ignore running
costs and so on; just consider the ‘capital’ cost of the car.
By retaining the car, you are forgoing a cash receipt of £6,000. Thus, the real sacrifice, or
cost, incurred by keeping the car for your own use is £6,000. Any decision that you make
with respect to the car’s future should logically take account of this figure. This cost is
known as the ‘opportunity cost’ since it is the value of the opportunity forgone in order
to pursue the other course of action. (In this case, the other course of action is to retain
the car.)
Activity 2.1
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